It remains to be seen if gold can withstand rising U.S. interest rates (if they go up) even with negative interest rates elsewhere in the world, especially as physical demand (i.e. jewelry) for the precious metal wanes.
Negative performing alternatives centered around commodities, as West Texas Intermediate (WTI) crude oil lost -13.9% on the month to close below $42/barrel, after rebounding to over $50/barrel intra-month. Crude prices have slipped as the U.S. rig count, produced by Baker Hughes, continues to rebound, the Saudi’s continue to cut pricing to Asian buyers, and both OPEC and other oil producing nations increase output.
Stock piles of both refined product (i.e. Gasoline) and unrefined crude remain near record highs heading into seasonal slowdowns in demand from refiners. Furthermore, according to the Commodity Futures Trading Commission (CFTC) short bets against WTI increased by 38.897 contacts for the week ended July 26, hitting an all-time high. It remains to be seen where crude prices go from here, but it appears the path of least resistance is lower for the foreseeable future. On the currency front, the U.S. Dollar weakened -0.6% on the month, but lost more than -1% after the Federal Reserve left interest rates unchanged. The forward path for the Dollar likely remains higher, but at a slower pace than in 2014-2015.
Another FOMC meeting came and went during July and still no further evidence of a Fed ready to hike interest rates. Bond yields touched all-time lows during July following the surprise UK Brexit decision, only to quickly spike higher after the strong June jobs report was published.
The FOMC is obviously weighing a lot of factors as they debate when and how to begin unwinding the massive stimulus in place since 2009. Despite historically low interest rates, investors continue to pour money into bonds, most recently buying emerging market debt in a vain attempt at finding yield. As US Treasury yields plummeted, investors turned to riskier areas of the bond market, with the ML US High Yield Master Index gaining +2.53% in July and the ML USD Emerging Market Sovereign & Credit Index rising +2.17%.
The ML US Corporate Master index rose +1.45% while the ML US Treasury/Agency Master Index tacked on +0.42%. Year to date, most fixed income classes are sporting equity-like returns, either handsomely rewarding astute investors for eschewing risk, or setting them up for a wicked reversal should growth surprise. The yield curve continues to flatten as evidenced by the chart to the right. Short-term rates are edging slightly higher while both the 10-year and 30-year have seen their yields plummet.
The 2/10 Treasury spread has dropped from 154 bps a year ago to just 81 bps today while 2/30’s has fallen from 225 bps to 155 bps today. The flattening yield curve hampers bank profits and has historically been a telling signal of impending recession.
While not a perfect indicator, something tells us that absent a Fed artificially holding down short-term rates, we would currently be witnessing a much flatter, if not inverted yield curve. With over 40% of international sovereign debt sporting negative yields, it’s no wonder investors are flocking to the relative value of US Treasuries. Currently the futures market is pricing in a 20% chance of a September rate hike and just a 37% chance for a December move. A more aggressive Fed would certainly force investors to rethink their current strategy of buying risk and duration and likely inflict a lot of pain across a wide swath of bondholders.